The 3 Metrics That Matter to Raise Your Series-A
For early-stage enterprise software start-ups, there is a disconnect between venture investors’ expectations for revenue, and the lead and sales velocity the founding team can deliver.
The venture market for Series A and beyond has shifted — investors expect multi-million ARRs and rapid growth. They’ve extrapolated backwards from successful IPOs and are looking at the metrics the likes of Slack, Twilio and other “unicorns” had when they were a seed stage company.
But the typical seed stage start-up doesn’t have the pipeline, processes and sales skills to sell fast enough to hit that growth.
We hear about viral adoption, product-led growth and network effects. But reality is that most start-ups acquire their first 20–30 paying customer in the trenches. What may look like a repeatable, predictable sales process is rather founder-led selling with hand-to-hand combat for each new account.
The struggle starts when the founders need to hand over the selling to their first sales rep. The rep is not productive, the go-to-market approach falls apart, and despite early product-market fit, the company fails to hit its sales targets required to raise more funding.
This is the first of two posts to fix that.
I started writing this post before Covid-19, but the conclusions hold even more true now. While there are still tons of money in the market, there’s been a “flight to quality” for investors. It’s pretty much a binary outcome at the Series A — as a start-up, you either have the metrics or you don’t. And when you don’t have them, it becomes infinitely harder to raise.
In this post, I’m outlining empiric trends for venture funding and capital markets to establish the connection between funding and revenue.
So here we go….
Changes in Venture Funding and Public Markets
Raising a seed round typically happens based on a vision that the founders are able to paint, about a big opportunity in a large market. The funding happens because of the shared belief in a big opportunity, and the founding team’s ability to deliver the first set of milestones.
For every subsequent round, funding has become a metric-driven exercise. Investors look at your traction, and the key metrics they care most about are ARR and ARR growth. The 2020 funding environment is much different than the one at the start of the last decade in 2010, and even as recent as 2015. There have been three major shifts.
- you need revenue for a Series A.
- how much revenue depends on your market / vertical, but it’s probably at least $1.5M.
- you need a “triple, triple” growth trajectory.
Let’s look at them in detail.
Shift #1 — You need revenue for a Series A
There used to be a time when you could raise your Series A based on product milestones with little or even no revenue. Those days are gone.
Consider research by Peter Wagner at Wing on what percentage of companies that raised a Series A generated revenue.
In 2010, only 15 percent of seed stage companies that raised a Series A were generating revenue. For 2018, that number grew to 82 percent.
Going forward, expect that number to be above 90 percent. The exception may apply for companies with complex technology, where you first need to spend the time to bring the initial technology to “general availability”. For example, artificial intelligence applications or a new type of database would likely fall into that category.
The message — you need to think about revenue from Day 1, and the key metric to track is ARR.
Shift #2 — You need to have at least $1.5M in ARR
But how much ARR / revenue exactly do you need? From my experience, the actual number differs based on your industry, how competitive it is, and what firm you’re talking to.
What everybody does seem to agree on is that fund sizes for the top firms have gone up. Jason Rowley has published Crunchbase data on how the percentage of funds with more than $500M of capital raised has grown from the 30–40% range around 2010 to 66% in 2018.
Along with the fund size, the check size for Series A has gone up.
Consider that a partner at a venture firm can handle about 3–4 new investments per year (and that’s already a lot…). Now assume that once a fund is in place, the number of partners doesn’t change.
And so if:
- a fund’s size has gone up, and
- the number of partners in the fund and the number of investments per partner both stay the same,
- then the size of each investment has to go up.
In fact, looking again at Wing’s research, the average Series A has reached $15.7M in 2018, up from $11.8M in 2017 and $5.1M in 2010. That’s a 3x increase within 8 years, certainly more than the rate of inflation.
The larger check size comes with higher expectations for ARR.
You’re not getting $15M+ in funding because you have some fancy product. You need revenue on that product, and not just “some” revenue.
At $15M, you’re looking at backing into some multiple. At a 10x ARR multiple, you’re looking at $1.5M in ARR. In fact, “minimum of $1.5M ARR” is a number I’ve heard on an anecdotal basis in many conversations.
The actual ARR number can be quite distributed though. I’ve heard numbers as low as $500K ARR for companies that operate with a distinct moat in a big and growing market.
On the opposite end, in mature and hyper-competitive spaces, such as outbound prospecting tools, I’ve heard about how companies with $4M+ ARR have struggled to raise their Series A.
As a rule of thumb, plan to deliver at least $1.5M in ARR. If the trend of larger funding rounds prevails, the number may even move towards the $2M ARR benchmark.
Now, it’s not just pure revenue. Investors want to deploy capital into a business with a revenue stream that has already been de-risked. Acquiring revenue in the trenches with one-time heroic efforts won’t cut it.
You need to show a predictable model, pipeline and most of all growth. That gets us to the next shift, for your growth trajectory.
Shift #3 — You Need to Have a “Triple, Triple” Growth Trajectory
How much growth exactly? Looking at Bessemer’s 2019 State of the Cloud report, cloud companies with “good” ARR growth hit the $10M mark in four years.
So assuming you already bring $1.5M ARR to the table, and you’ve spent 1 year on acquiring that, as a company in the “Good” category you have 3 years left to find the remaining $8.5M in ARR.
That’s a CAGR of 88%….
But rather than linear growth, investors want to see that growth “front-loaded”, with higher growth early on. That’s where the famous “Triple, triple, double, double, double” comes in, which Neeraj Agrawal from Battery Ventures wrote in 2017.
It’s a conceptual framework that helps entrepreneurs how to think about building a $1B company.
In his post, Neeraj uses data for public SaaS companies like Marketo, NetSuite, Omniture, Salesforce, ServiceNow, Workday and Zendesk shows those companies have followed that growth pattern.
Bessemer has mapped a few other companies, and you can see how the growth to $10M is in the 2–4 year and for $100M ARR in the 5–10 year range.
One of the greatest pieces of advice I got when we raised our seed round for intermix.io was to have the next round in mind, and what milestones to hit. It sounds so obvious, but it wasn’t to me.
When you raise your seed, investors will think “will they hit their milestones for their A?”; when your raise your A, they will ask the same question with your B round in mind, and so forth.
The lesson learned here is that for your milestones, investors will look at your growth rate from a SaaS benchmark perspective, not an industry perspective.
Therefore, for your Series A, hitting $1.5M+ ARR is one milestone. You also have to show the traction and momentum to create confidence that you’ll deliver the “triple, triple” part.
But your past ARR growth is just that — a measure of your past ability to deliver revenue.
The two metrics to understand the robustness of forward-looking growth are your “Lead Velocity Rate” (LVR) and your “Net Dollar Retention Rate” (I haven’t heard anybody use that acronym, but I’ll use “NDR”).
Lead Velocity Rate
The Lead Velocity Rate measures your month-over-month growth in qualified leads. The logic is easy — if you grow the number of qualified leads every month, your revenue growth will follow. I recommend reading up on Jason M. Lemkin’s post on LVR.
Net Dollar Retention
Net Dollar Retention combines two things into a single metric, your (1) ability to retain customers and (2) sell them more over time, aka grow your “share of wallet”. The “net” part refers to expansions net of contraction or attrition.
A simple way to look at this is to ask what $1 worth of net new customer spend today will be worth in “x” number of years from now. For example, Atlassian in its IPO prospectus showed that $1 of spend in Year 1 would become $7 of spend by Year 5.
That’s an indexed way of looking at things. A more intuitive example is looking at your different cohorts.
For example, Slack in its IPO filing defines a cohort as “Paid Customers who made their first purchase from us in a given fiscal year”, and plotting them gives you the colored layer chart. (go to the Slack S1 on page 68 for the original chart)
With Slack’s ARR chart, you can see how powerful a high Net Retention Rate is. Slack’s Net Dollar Retention for 2017–2019 is insanely high, and you can see how the number of customers paying them more than $100K per year keeps going up.
The layer chart shows how revenue from the existing customer base just keeps growing. It’s much easier to grow if you don’t have to fight attrition, but rather keep expanding the revenue coming from existing customers. Consider that with high Net Dollar Retention, you can detach revenue growth from logo growth — add the same number of logos every year, at a consistent first year ARR, and still grow faster year-over-year because of the expansions!
So where do you need to land for your NDR? Alex Clayton at Meritech Capital analyzed the Net Retention rates for various public SaaS companies, incl. normalizing for different definitions of NDR.
The vast majority of companies land over 100% (in blue). The median is 117% for net dollar retention disclosure and 92% for gross dollar retention disclosure. So at the very least, you want to be over 100%, but better is above the median with ~120%.
If you’re seed stage, it gets a bit fuzzy for NDR by definition, with little historical data, but you could measure it at the quarterly level, or at the very least show how there’s no logo churn.
The Sales Metrics you need to hit at Seed Stage
So what does this mean if you’re just at the beginning of your start-up journey, and you’re about to go out and raise your seed round?
You need to plan ahead for the time ahead when you’ll raise your Series A.
This may sound again so obvious. But it’s easily forgotten by punching in the ARR number you promised to your investors into an Excel spreadsheet, and then using the CAGR to fill in the rest between now and then.
The 3 metrics to raise your Series A
Instead, you need a detailed plan to to hit three metrics before you go out to raise your A. You have to show:
- ARR in the $1.5 - $2M range within 18–24 months (and with at least 3 months of runway left…)
- LVR to reach $10M ARR within 2–4 years
- NDR of 100–120%
You hit those metrics — and you’re in good shape. Hit 2 out of 3 — the conversation might take a little bit longer. Hit none — it may be time to pack up and go home, or if you’re lucky do a seed extension.
[Note: adding a comment I received on LinkedIn on this post by Dan Scheinman, on quality and repeatability of revenue. Dan is one of the greatest angel investors out there. It’s ok to have lower ARR if you can show repeatability of revenue. I much agree with Dan’s assessment.
Seed Rounds, Capital Efficiency and ARR
Now let’s look at the math to get to those metrics.
A “classic” seed round is still around “2 on 8”, i.e. a $2M raise on a $8M pre-money valuation. Going back to Wing’s research, the average seed capital raised before a Series A in 2019 edged up to $3.9 from $2.6M in 2013. Recent Crunchbase data also shows how seed rounds have grown.
Let’s use some round numbers and assume that you raise $4M in your seed, and that’s what you have at your disposal to get to $2M in ARR.
With a $4M seed, you’re looking at creating ($2M/$4M) = $0.50 in ARR for every $1 of burn, and you’ve got up to 24 months for that.
I’m using round numbers, and you can replicate the math with different inputs.
But it’s a tight ratio, and it means you have to be really capital efficient and effective in ramping up your sales. And the smaller your ASP is, the more leads, conversions and sales you have to create.
Sales at Series A and beyond
Which takes us back to sales. If we learned anything up to here, it’s that early stage investing has become a metric-driven exercise. And you need to hit those metrics.
To hit those metrics, you need to build an efficient, predictable sales motion, and that’s where your marketing and sales operations come in, and the team you hire to execute it. The opportunity cost of a wrong hire, lost time to build pipeline — it’s huge.
I’ll cover that in another post. I’ll share a framework how to think about building the sales motion for your start-up, for Series A and beyond.
If you’re about to raise your seed, and want to think through your sales strategy and your next round — shoot me a note on LinkedIn, I’m happy to help!
If you’re not quite ready yet —meanwhile, click the link below to subscribe to my weekly newsletter “Finding Distribution”. Promise it will make you smarter! :-)
